The Asia-Pacific region is large and diverse in its mix of developed and emerging economies, with a host of different regulatory regimes. While data is hard to come by on the extent of environmental, social and governance and sustainability practices in private lending in the region, managers and service providers report an increasing focus on such matters.
This is in line with the wider APAC business world, where ESG has become a more important consideration for business leaders since the outbreak of the covid-19 pandemic. A recent Baker McKenzie survey of 800 APAC business leaders found that 90 percent considered ESG matters in their investment activities and 46 percent said they were taking such matters more seriously since the pandemic.
Alastair Gourlay, a partner in law firm Baker McKenzie’s banking and finance group in Sydney, says: “ESG/sustainability is growing in importance in the APAC private credit market and we expect this trend to continue. Until a couple of years ago, this was largely limited to excluding investment in certain sectors, for example investment in fossil fuels, but we are now seeing funds actively seeking to lend to companies with a sustainable business model.”
Roger Zhang, head of APAC private debt at investment manager Partners Group, adds: “We see a lot of new hires for ESG professionals in Asia, which is a sign that it is being taken seriously.”
The key driver to private lenders’ ESG awareness is demand from investors. Large institutional investors which have adopted their own ESG principles and adhere to ESG guidelines will often have significant influence over the implementation of ESG principles throughout their investments. For example, all the investment managers Private Debt Investor spoke to for this article have signed up to the UN-backed Principles of Responsible Investment and anecdotal evidence suggests many private lenders in the region have also done so. Additionally, managers that operate globally tend to adhere to the best global practices, which tends to mean they are ahead of the APAC norm.
Mick Wright-Smith, founding partner at Australia’s Epsilon Direct Lending, says: “Almost every investor we speak to asks what our ESG policy is; if you want to raise money in private credit in Australia, you need a good answer to that question. We have signed up for the UN PRI and I see that many other lenders have done too.”
Investor promotion of ESG practices is not limited to private lending. Large investors have been pressing for greater corporate ESG disclosure, transparency and reporting requirements in the APAC region, including calls for ESG-specific regulation. The heterogeneous nature of the APAC region means there is far less consistency in ESG regulation than in North America or Europe. However, developed markets such as Australia, Hong Kong, Singapore and Japan are making progress in this regard.
For lenders, ESG due diligence is becoming a key component in the process of investment decision-making and portfolio management, and it is becoming more common for fund managers to carry out formal due diligence on ESG matters at early stages of the investment process. Wright-Smith says: “Our ESG policy is built into every stage of our investment committee screening process. Our early-stage credit paper will highlight potential ESG issues which must be resolved or explained for the transaction to clear our investment committee. This might involve desktop research, following up with the borrower or third-party diligence.”
Chris Bone, head of private debt, Europe at Partners Group, says: “The first stage is whether it is an industry we want to lend to, then the investment team together with our in-house ESG specialists will make a detailed assessment and, once the investment has been made, we will try to look to ensure that portfolio companies manage ESG risks appropriately and report on ESG on a regular basis.”
Bone adds that Partners has also “introduced incentives in some transactions, where borrowers will benefit from better ESG performance, however this is less common in Asia”.
There is a reporting burden on both managers and borrowers due to ESG requirements, which is felt more strongly by smaller organisations. The need for all parties to upskill in this regard is demonstrated by the number of companies seeking to employ ESG specialists.
Leo Vellis, a partner in Baker McKenzie’s funds transaction group in Sydney, says: “Reporting requirements and information sharing in respect of ESG data allows the fund manager to not only ensure that ESG risks are being managed appropriately, but also to provide the fund manager with the necessary information it needs to comply with ESG reporting to investors.”
While green bonds and sustainability-linked bank loans have grown rapidly in Asia-Pacific, there is still relatively little sustainability-linked private lending, says Chris Mikosh, co-founder and portfolio manager at Tor Investment Management. “We are starting to see some green bonds and loans which are certified by external agencies confirming certain criteria is in line with the Green Bond Principles, but these have largely been outside of our focus, from a return standpoint.
“There are a number of opportunities in APAC to lend to borrowers that promote environmental sustainability at mid-to-high teens IRRs. We have lent to an electric vehicles business in Australia, a geothermal heating business in China, a wind farm equipment manufacturer in India and a hazardous waste management facility in Australia, to name a few.”
Baker McKenzie’s Gourlay says: “We do, however, expect there to be an uptick in these loans in the coming months and years as the incentivisation for putting them in place starts to outweigh the challenges. This incentivisation will come in a number of ways, such as investor and competitor pressure in the case of private credit funds; and through pricing and simpler, streamlined compliance regimes in the case of the borrowers.”
There is a small number of debt vehicles being formed in APAC with specific ESG and sustainability characteristics. In April, investment manager First Sentier Investors and Japan’s MUFG Bank launched a private debt fund focused on loans to the renewable energy sector. The sustainable debt strategy has secured the backing of a cornerstone investor and made its first loans.
Meanwhile, in June, the Muzinich Asia Pacific (APAC) Private Debt I fund was launched by investment manager Muzinich & Co, with Singaporean bank DBS as the anchor investor, committing up to $200 million.
ESG practices are not consistent across the various nations of the APAC region, but there is also some inconsistency in how they are applied within markets. Epsilon’s Wright-Smith says: “In the past four months, we have looked at around A$2 billion ($1.47 billion; €1.25 billion) of opportunities and declined around A$100 million on ESG grounds. However, other lenders have taken them on.”
In the US and Europe, the practice of “greenwashing”, or exaggerating the extent of ESG practice, has been hitting the headlines, but there is less examination of company practice in APAC. However, different outcomes do not always reflect a failure to comply with best ESG practice, but rather a different perspective of the risks involved. Partners Group’s Bone says: “Assessing whether an investment is suitable from an ESG perspective is not always straightforward and can depend on a multitude of factors.”